Making Cents: What Goes Up, Must Come Down?
By: John P. Napolitano, CFP®, CPA, PFS, MST
If I had a dime for every time that I’ve heard this saying with respect to the capital markets I’d be one of the richest guys that I know. Since the economic meltdown we had ten years ago, equity markets in the US have done one thing. Appreciate. Not only has appreciation been generating record levels, this level of appreciation has occurred with significantly less volatility than usual.
Those who live in the “what goes up must come down” world may understand physics, but I’m not sure that they truly understand economics. It is reasonable and prudent to assume that all capital markets will appreciate and depreciate to lower values at any point in time. But I hear many who talk in terms of waiting for the next market decline as if the decline is permanent and irreparable.
Of course permanent loss can happen to concentrated positions. A concentrated position isn’t some fancy name for a specific type of investment. It simply means that a high percentage of your investment dollars is concentrated in one holding or sector.
Just ask holders of shares in companies that no longer exists how painful concentration risk can be when it turns against you. The term concentration can also apply to an asset class. For example, a landlord who invests in nothing but real estate would have an investment concentration in real estate. Similarly, an investor who owns very large positions in a closely held business or even a multi-national conglomerate is also concentrated.
Historically, broad market declines have not been permanent. I’d be negligent if I didn’t chirp that past performance is no guarantee of future results, but historically the markets do frequently rise after a prolonged period. Think the 1929 crash, Y2K, Banking Crisis and so on. During these events, investors were devastated by the losses in their portfolio and many were so scared that they moved to the sidelines forever. Of course, looking back this time, these same investor realize the long term opportunity cost of their decision.
The past year has also surprised many investors. Many of these investors are preaching the ‘must come down’ story again. While they’ve been wrong for the past 14 months – there will be a time when they are correct. Things will go down again.
With that reality now front of mind, the question is how will you tolerate the next drawdown? If you’ve been on the sidelines, maybe that next market decline is your chance to finally buy at a level you feel is fair. If you are invested, understand the inherent volatility in your holdings, and assess just how volatile your portfolio may get. With this information, you may now be in a position to re-allocate to a less risky or more aggressive portfolio or to un-concentrate your holdings.
With markets, only two issues frequently repeat themselves. Markets will rise, and markets will decline. Understand just how much of each you can tolerate and what you need to do to get your portfolio in a zone that works for you.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification and Asset Allocation do not protect against market risk.
John P. Napolitano CFP®, CPA is CEO of U. S. Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.